I am a registered investment advisor based in Houston Texas, specializing in equity options. My focus is naked put selling and spread trading. I have past experience in commercial banking, real estate, and oil and gas, as well as various types of other derivative investments. My world was turned upside down by the financial crisis of 2008-9. Many of my views are slanted to expose and correct the corruptions existing in the world’s financial markets. I have a BS in economics from UC Berkeley and an MBA in finance from the U of Pennsylvania Wharton School. Reach me at rbf10@comcast.net

The U.S. Debt Ceiling Fallacy: Agreement Or Not, There Will Be No Default

Black’s law dictionary has this to say about “default”: The omission or failure to fulfill a duty, observe a promise, discharge an obligation, or perform an agreement [or observe a promise or discharge an obligation (e.g. to pay interest or principal on a debt when due ].

Come October 17 if our dysfunctional Washington hacks do not raise our debt ceiling, ominous forecasting of imminent default on our $17 trillion burden pound the airwaves. Prevarications foisted by the progressive press-corps regarding the United States becoming delinquent on its Treasury debt are as preposterous as they are disingenuous. Whether premeditated lying or, equally likely, out of a stark darkness of matters economic the result is the usual fear mongering we have come to expect from their rumor mills.

Inconvenient as they may be, some facts are in order. The fiscal 2013 debt service for the twelve months ending September 30 will be somewhere around $420 billion. (Per the Bureau of Fiscal Service the actual figure of 11 months through August was just under $396 billion). IRS revenues for the calendar 2012 tax year will probably be around $2.3 trillion. That equates to over a five and a half times debt service coverage. So having enough money is not even close to the issue. There has been some discussion of what some are naming “prioritization of payments”.

The naysayers argue that most of the Treasury payments are on computerized auto-pilot and that tinkering with such complexities is tantamount to doing a 180 on an aircraft carrier; it takes a long time and gigantic effort….so it may be difficult but still doable. There is talk that the Mr. Obama has rights under section 4 of the 14th amendment to raise the debt ceiling or issue an order to get interest paid. Legal scholars remain sharply divided on presidential constitutional authorities granted. Mr. Obama disregarded the constitution and rule of law by unilaterally extending Affordable Care Act a year for corporations. If he wants to pay interest, he can.

Why the U.S. Will Not Miss a Single Payment

The short answer is we cannot afford the repercussions of what a true default would mean. Worldwide there are hundreds of billions or trillions of overnight repurchase agreements or repo’s between banks that use our Treasurys as the collateral for these short term loans. Second, large banks such As JP Morgan (JPM), Bank of AmericaBank of America (BAC), and Citibank (C) hold a significant percentage of their reserves in Treasury securities. Were the value of Treasurys to fall sharply due to a default or even a perceived default, it would make what happened in 2008 after the Lehman debacle look like a children’s exercise. If the Treasurys for repos became suspect and unacceptable as collateral, financial markets would effectively collapse and be shuttered. The other corollary is that as the value as Treasurys sink, banks capital ratios get punished and may go below statutory limits. If there were an actual default then banks would illegally be holding a defaulted instrument as part of their primary capital. Pension funds and other institutions are by charter often not allowed to hold defaulted bonds. Runs on banks would soon follow and a massive recession would result. It is a nightmare scenario too horrible to contemplate.

What the Markets Think

In the three trading days since the government closure, the stock market has lost less than one percent. Far more important is the reaction of the bond market, in particular the price action of the 10 year Treasury note against which mortgages are priced and is a benchmark of comparison with other 10 year securities in other developed nations. The 10 year note closed today at 2.61 percent its lowest yield (highest price) in seven weeks……no indication of panic. If the giant bond funds like PIMCO and Blackrock which own hundreds of billions in Treasurys of all maturities were truly concerned about a cataclysmic event like a default, an orderly liquidation of portfolios would already be underway and 10 year rates would be going up and not down. Another barometer of bond market jitters is the interest rate spread between our 10 year Treasury note and the German 10 year bond referred to as the “Bund”.

If the world was expecting turmoil in our treasury market then that spread would be expected to widen because investors would sell the falling Treasurys (rates go up) and buy the flight to safety instrument, in this case the Bund’s (rates go down). Over the last couple of weeks that spread has held steady, and in the last three or four sessions it has actually contracted by 6 or 7 basis points. The same exercise with the 10 year British instruments called Gilts yields similar results. A bond trader’s job is to analyze credit, and the markets are speaking loudly that right now there is ZERO worry of a U.S. government debt default.

Some More Numbers

The actual monthly interest expense due varies widely. Historically the biggest maturities come in December and June. December 2012 and January 2013 were $96 and $93 billion respectively or over 45 percent of annual obligations. October 2012, on the other hand, registered the lowest interest amount due at less than $13 billion. October 2013, which would be the ostensible drop dead date for a debt ceiling increase, is the month our government has the least economic burden in terms of its debt service obligations. Assuming there is no deal, there will be plenty of cash on hand to make what is effectively the October mortgage payment. Going forward if no accord can be reached, as demonstrated there is plenty of cash to meet our obligations……but there is not plenty of funding for everything. Something like $850 billion is the estimated deficit for fiscal 2014. Services would be cut across the board. No one knows for sure how the austerity would be spread because our country has never experienced extended period when the debt ceiling has not been raised by Congress when required to meet our obligations.

While I would like to see a debt ceiling compromise, it should only come with a plethora of across the board spending cuts from entitlements to farm subsidies, to defense…..nothing is sacrosanct. Our current Debt to GDP ratio is an unsustainable 105 percent, projected higher for at least the next several years. There will be a point when the rest of the world will begin demanding much higher rates to compensate for such a deeply indebted nation. While there is ample blame to go around, Mr. Obama needs to step up and be a leader. I heard him in two interviews talk about default as if he were some passive bystander being blown in whatever direction the wind carries him. The dollar, however weakened, is still the world’s reserve currency. Our economy, however wretched, and our Treasury securities are still looked up to as the safest place to park funds. Mr. Obama should be reassuring the world, debt ceiling agreement or not, the United States of America will not default under any circumstance on its debt obligations. It is tawdry behavior to use this issue as a political football.

P.S. The first Friday at 8:30 EST is traditionally the release of the monthly employment report. In keeping with vindictive style, Mr. Obama had this important statistic withheld this morning under the flimsy pretext of government shutdown. Mr. Obama currently presides over the largest and most expensive white house staff in our nation’s history. Surcease of this agency should be placed up for review as well.

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No disrespect, but your writing is atrocious. If your objective is to inform, edit or have someone edit your work, so that the reader doesn’t have to think about what you’re trying to say, but instead can consider what you say. Otherwise, what’s the point?

By your own cited definition, not paying the legislated obligations would be “default”. I’d also like some sort of evidence that the shutdown is a “flimsy pretext” for there being no employment statistic released.

Just one thing to add: Article 14, Section 5 empowers CONGRESS to enforce the provisions of the Article. Thus, further unconstitutional action on the part of the President is unnecessary. Congress has the duty to direct the Treasury Department to prioritize debt service. It also has the power to modify any other obligations (so-called “mandates”) to make the money available if the Administration fails to do so.

it seems that you have forgotten that this is still the same Congress that can’t even pass a budget, but then maybe the thought here is that when it comes to making sure the gamblers get paid, they’ll come together.

@Richard Finger – I agree with the below comment here – you’re just throwing gasoline on the fire with this kind of rhetoric. Maybe instead of clever terminology like “prioritize” to make something sound less insidious than it is, maybe you should just say it plainly. In default, without the means to borrow, there is not enough to pay for everything, and you don’t care who is sacrificed so as long it doesn’t include any of the Wall Street Aristocracy.

I think this is what makes me most irate, though I’m not 100% clear on how this entire process works. I understand that tax revenues will cover debt payments. Got it. But is this midnight hour budget melee necessary? How can an administration make expenditure plans, get authority from Congress, and then need to scramble to figure out which payments are “priorities” because the same Congress can’t compromise on anything, leading to a last-second scramble to figure out if VA benefits or Social Security are more important? Add in the fact that most of the junior and middle-level analysts in the Fed are probably on furlough right now. We’re talking about trillion dollar programs requiring massive amounts of data crunching and serious analysis. It’s not like the Treasury Secretary and a dozen of his best people can order a few pizzas, shack up in an office, and hammer out an alternative expenditure plan that has billions of dollars of variables mounting on a daily basis. Wouldn’t a responsible Congress have passed a budget and figured out all of this compromise garbage a long time ago? Why don’t they just take a vote on the budget bills as they are now like the President has been saying and take this fight into next year?

The thesis of this article seems to be: - A default can’t happen because the consequences would be unthinkable. - A default can’t happen because surely Obama would prioritize Treasury payments above over expenditures, such as welfare checks. - Obama will do whatever he wants because he has claimed the right to ignore the Constitution, and no one has challenged him on this behavior in a way that has teeth. These arguments are specious with regard to substance. The fact that the article is also rife with typos and grammatical errors does not inspire confidence, either.

This is an example of the wooly-headed thinking that is leading the Tea Party folks to run us over a cliff. The notion that not extending the debt limit “wouldn’t be so bad” is idiotic – for one thing it would make a downgrade of Treasuries by Fitch likely, which would then have two rating agencies rate them as AA instead of AAA. That would have permanent and serious long-term adverse consequences.

You really think the rating agencies are going to downgrade the US ever again after they’ve been retaliated against with the full force of the justice department? Wake up and smell the wool in your own head.

The rating agencies are such discredited organizations that their words have less impact than in the past. Since the last downgrade, US debt has had stronger demand than ever. Like the Gandhi aphorism. Thanks for reading and commenting. R

That Treasury link doesn’t claim that re-prioritizing expenditures is hard. It just makes a massive rhetorical leap to equate it with default:

“Adopting a policy that payments to investors should take precedence over other U.S. legal obligations would merely be default by another name”

So, reducing military spending is default? Canceling hardware orders we have the contractual right to cancel is default? If the shoe were on the other foot, the same people would be arguing that when Congress decides not to cut a check, it’s basically the same thing as repealing a program. Since they have the power to do both, why pick at nits? The left has shown no more interest in legal higiene than the right, until it suites them.

It is particulary troubling to see this kind of talk coming from the Treasury. I would hope for at least a nod to the appearance of objectivity and neutrality on their part. Perhaps the Deputy Secretary can explain why markets respond positively to a company that addresses forecasted losses with a serious restructuring of its obligations and operating costs, but would be spooked by a government demonstrating the same behavior. The Treasury, of all organizations, should understand that most of the weight of US creditworthiness should rest on our actually having collected the money to service our debt, rather than on our ability to increase borrowing forever or our ability to devalue existing dollars.

The markets aren’t tanking because they believe John Boehner when he says that he won’t allow the government to go into default over the debt ceiling. If Ted Cruz was Speaker of the House, the markets would be in chaos.

Did you not read the article? There is zero chance of a default. Obama is simply lying to the American people when he says we will default on our debt. There is just no way that is going to happen. Obama is using his scare tactics to try and keep his Affordable Health care law floating, a law that will cause great harm to our economy. Some peoples health insurance is going up by over 100%. People can not afford this insurance so they will simply just pay the penalty. In the end this HCL will end up on the back of the tax payers.

Finally! Only if more could read this. As a father of 4, I fear this debt is enslaving our children. Interesting how Obamacare also uses the young to pay for the old. A healthy home has a balanced budget and if we can, savings for education. Hard to believe in government anymore…

Don … the young have always paid for the old … unless you plan on forcing old men and women to work until they die to pay for food, medicine, and rent.

The Affordable Care Act – insurance premiums are set in place by private insurance companies.

When you were single and paid for insurance, your premiums helped to subsidize the cost of health insurance for families. Which means your single co-workers without children, are subsidizing your health care for your family.

Healthy people who never or rarely use their health insurance, help subsidize the premium for people who use their health insurance all the time.

Most Healthy homes with a balanced budget … means they don’t use credit cards, buy & pay for their cars/homes off in cash. If you use any form of credit, your budget IS NOT balanced.

So, you seem to be making the point that not raising the debt ceiling is not default because we still have IRS income to pay out bills. The default idea comes from needing to instantly cut programs because we can not borrow enough to cover everything and that job is so difficult in the current political environment it seems impossible.

Since the Post-World War II Bretton Woods Agreement, the United States has become a monetary standard that stabilizes the world. If the potential to lower spending if the debt ceiling isn’t raised is in the practically impossible range, might this not be the time to look at the weight America carries in a much stronger world and the hardship that our debt and world obligations cause to our people and allow this progression to continue to a true default bankruptcy. Many countries and corporations with much larger Portfolios and Sovereign Wealth Funds and much lower debt depend on the United States for their existence. Maybe that should change? Maybe the time has been set for now over the just cause of giving our people access to a level of healthcare that is common in many parts of the world that depend on us for their security.

“No one knows for sure how austerity would spread ” is actually because, No Country has ever cut itself out of debt !!! Our problem is not that we spend but rather that we spend on the wrong things ! Cutting taxes on the top earner’s has not promoted growth, EVER ! Except for the growth from the Internet boom, we have not promoted growth since the massive 81 tax cut took top tax rates from 73% to 28% ! In fact 83 had the highest unemployment rate since WWII ! We need to spend on things that put cash in Middle Class pockets, like infrastructure and rebuilding America ! Eisenhower and Roosevelt seen this and acted, today were run by the immediate profit rule, until our eyes are on whats best for the majority and not those at the top we will see a bleak future ! Trickle Down has proved that it doesn’t work, history proves that our greatest growth came as the working man had more in their pockets and pushed the economy up !!!!!

This article was enlightening and very well done as far as it went. The thing is that the United States has other obligations beyond just debt service. As another poster mentioned, they have contractual obligations for contracts that they have already entered in to. They have huge obligations as far as the military budget. The thing is these expenses have already been authorized by congress. Another thing is what about debts that are being called in. Bonds get cashed in and if debt service to what our congress and senate has borrowed from Social Security isn’t enough to pay everyone then some of those bonds need to get cashed in, also. It is all a really huge mess.

I do agree with the author that expenses need to be cut across the board and nothing should be sacred. The thing here is not only do individual congressmen and senators have their sacred cows, but each party has a different set of priorities. The author’s idea of just cutting everything and not catering to the interests of one party or another is a very good idea and especially this is no time to cut taxes. Some targeted tax cuts might be alright, if the income from those taxes are replaced with income from a new tax or an increase in another tax, but that would just cause more bickering and gridlock, so it wouldn’t work. Another thing that should be done is Boehner needs to stand up to those Tea Party congressmen and at least allow things to come up for a vote. It is ridiculous that one faction of the Republican Party has been able to grab so much power over the majority and this type of blackmail cannot be given in to, because it makes the problem worse in the end.